9/14/2009 @ 4:00PM

Recessionary Retail Therapy

The recession has led to lots of cost-cutting measures. That trip to a Caribbean island is on hold, you only go out to eat for special occasions and the Armani suit will have to wait. However, once people start feeling more confident about the economy, those consumers who are starved for their rack of lamb will be headed to the nearest restaurant. So raise a glass; here’s to eventually eating, drinking and traveling our way out of this recession. Clink.

Some people have been feasting despite the recession. Hilary Kramer, chief investment officer of A&G Capital Research, says brand loyalty will get companies such as Cracker Barrel Old Country Store, Inc. through this recession. Cracker Barrel was selected “Best Family Restaurant” by Consumer’s Choice in Chains for the 19th consecutive year. The restaurant also just celebrated its 40th anniversary and in the third quarter the firm’s revenue of $567.6 million was up 0.1% from a year ago.

Kramer also recommends
Darden Restaurants
, Inc., which owns Red Lobster, Olive Garden, LongHorn Steakhouse, The Capital Grille, Bahama Breeze and Seasons 52 restaurants. Darden is well-managed and trading at a discount, Kramer says. The company’s second-quarter earnings were $58.5 million, up from $44.1 million a year ago.

Though there are plenty of restaurants that have some potential to grow, the fast food area doesn’t look as appetizing for investors, Kramer says. She’s staying away from that area, as she thinks firms like
McDonald’s Corporation
and
Chipotle Mexican Grill, Inc.
won’t see the kind of growth that other chains will experience.

Retail sales fell by 0.1% in July, and are expected to rise 1.2% in August, according to economists surveyed by Thomson Reuters. Their full report will come out Tuesday.

Chris Armbruster, senior research analyst at Al Frank Asset Management, argues fast food joints haven’t been hurt as badly by the recession as restaurants in the higher-end category. “Fast food chains aren’t really deviating from the status of other restaurants,” he says. Ambruster recommends investing in McDonald’s and Darden.

Ryan Detrick, senior analyst at Schaeffer’s Investment Research, recommends
Cheesecake Factory
as a good investment in the restaurant sector, as the company’s stock value has almost quadrupled in price since the end of last year. It should be noted, however, that Standard & Poor’s rates the firm a strong sell and estimates comparable same-restaurant sales to decline 4%-5% for 2009. S&P also believes that new units will only offset some of that decline.

Detrick acknowledges the restaurant sector hasn’t done as well as the retail area. Retail investments have done surprisingly well, despite many traders shorting these companies assuming that consumers would be spending less money on clothes, food and other consumer discretionary purchases, he says. His investment strategy involves picking companies that have negative consumer and analyst sentiment but, despite that, the stock price is increasing. This signals that there’s more money on the sidelines, he says. Based on that strategy, he recommends
Whole Foods Market Inc.
, The
Gymboree Corporation
and
Jo-Ann Stores, Inc.
.

For investors who are hesitant about stock picking, invest in the Consumer Discretionary SPDR, an exchange-traded fund, Detrick says. He foresees consumer discretionary investments as having higher returns than the overall market for the next three to six months.

There are other consumer discretionary investments than just retail stores and restaurants though. Travel destinations and modes of transportation aren’t fairing that well.
Six Flags
, Inc. had second-quarter earnings down 13% from last year at $302.1 million primarily from reduced attendance and guest spending, the company says in their earnings statement.

Vacation ownership and business travel has suffered, as time shares are one of the first things that families will get rid of when they’re cutting costs, Armbruster says. Cruises have held up well though, he says. He monitors
Carnival Corporation
and
Disney
Cruise Line. “Cruises offer a nice alternative to more expensive vacations that people would have taken,” he says.

When people start taking more of these vacations and going out to eat, that’s when we’ll know that the economy is turning around. Unless you’re paying for your meal with government stimulus money, says Ken Shubin Stein, head of hedge fund Spencer Capital. “In the Cash for Clunkers program, what we effectively did was we took everybody who was a potential marginal buyer of an auto in the next six to 12 months, and we moved them forward to this period,” he says.

Perhaps the best way to gauge whether the economy is in full recovery mode and we’re feeling good is looking at laptop sales. Bill Singer, shareholder at Stark & Stark law firm, has a “laptop theory” where all of the people with aging laptops who want to get a new one but can’t will buy en mass as soon as they’re able to. Given that, Singer says to buy into
Dell
Inc. when these purchases start.

Eating Your Way Through The Recession

Forbes: What are the retail, travel and leisure and restaurant stocks that might do well in a jobless recovery? Or should individual investors be avoiding these stocks completely?

Hilary Kramer: I brought this up because I watch these sectors very carefully and I found this fascinating, the opportunities in the bear trap here. On the restaurant side, I actually see upside in a few specific names. I like Cracker Barrel; they’re trading at a significant discount to their peers and they’re also selling at a 30% discount to their five-year average P/E. And I believe even in a recession, even in a jobless recovery, even in a credit-squeezed consumer economy, there’s always some loyalty to brand, loyalty to brand is important and I think that Cracker Barrel has it.

Also, as an opportunity, there is Darden, Olive Garden and Red Lobster. And they’re very well managed. They’re also trading at a discount. They’re almost 25% to their five-year average P/E. And I believe
Panera Bread
, when I look at them, there’s still growth. In 2009, they’re still going to experience above 5% in terms of expansion rate even though it’s been 15 — 20% over the last five years. But you have this switch, this step down, where consumers are heading more to the Cracker Barrel, Olive Gardens and Paneras and heading away from some of the Outbacks, some of the chain restaurants that are higher-end, higher ticket priced. Believe it or not, I had been one of the biggest bears. I shorted DineEquity for a number of months. DineEquity has
IHOP
and Applebee’s. I’ve been very impressed with their expense control, their cost cutting, their negotiation on their highly-commodity sensitive inputs and they’re packed. DineEquity has really been able to pack in people into Applebee’s.

Now McDonald’s, as we know because they came out with their store sales, was slightly disappointing. They’re, that’s not one that I think there’s going to be upside. So where I see opportunity is Darden, Panera, there could be another 10-20% upside. And, keep in mind, it was very interesting. The restaurant stocks had an amazing recovery but it was very short term. It was eight weeks from mid-March into April. Some of those stocks quadrupled. Some of those stocks, like
Ruby Tuesday’s
, went from a buck to $7. And then they lagged, and they started to lag because of concern over them being squeezed over inflation, commodity prices rising and the consumer not having money. So there I see opportunity.

On the retail side, I am immensely concerned, especially, I see companies like
Sears Holdings Corporation
that have shocked the Street in terms of their decline in sales and in income potentially falling to dangerous levels in terms of having to pay down debt but not having reserves to do that. And many of these companies, like a Sears, have played every game in the book in terms of layaway, providing credit cards, every trick in terms of inventory. Every accounting trick you can possibly imagine. And, on the other side, on expense control, we’ve all read these research reports all over the Street that have one person per floor and the way Andy Lampert has run Sears.

Now, I’m very concerned, I wish I knew as we’re talking how many employees Sears has and Kmart but if Sears and Kmart have to go into a Chapter 11, can they restructure to be a Chapter 7 where other retailers like
Target Corporation
are just going to pick up the real estate. So what are we looking at, 100,000, 200,000-plus unemployment that could stem from that, not to mention ancillary employees that service companies like Sears as well as those that provide specifically to them on the appliance side.

That being said, I’m also, and we’ve had some good news in terms of the retail side, the clothing retailers, I’m still very hesitant on companies like
Aeropostale
, companies like
the Gap
, even though Old Navy was up 4% in sales last month. But
Abercrombie and Fitch
, these companies have expanded, high expensive rents and these are discretionary purchases.

Now, on the travel and leisure side, I think that the sell-off of Carnival and Royal Caribbean, I think it’s been overdone. Even though they’ve had to cut prices significantly, booking trends have actually stabilized and they’ve been able to fill these ships. Now, there have been issues because there are still new ships that Royal Caribbean ordered that they’re going to have to take delivery of but most of their ships, even institutional investors don’t realize the sweet deals that have been cut in foreign entities to build them. They’re really very inexpensive to build.

So, I’m not as concerned there as some are, but I am concerned about event companies like WWE, International Speedway. You know, we already saw with Six Flags who knows either fare even though they’re a fixed destination. Even if you get the same number of people coming through the gate, they’re going to be buying less, go for the less expensive package.

And I think that the boat industry and the recreational vehicle, the Winnebago, they’re not done yet. And on the boat side, Brunswick, you know I actually thought that they were going to go down November, December 2008. But they did come back around. But you know I’m very hesitant there, although interestingly there are some analysts who don’t like Harley Davidson. I think that’s a very strong brand and they will survive. They will find a way to survive and they are well-run franchises.

But I think that the Street and sell-side research has been pushing investors to jump into clothing retailers, discount retailers and we have to keep in mind the news that came out yesterday on consumer credit. Consumers don’t have the money to spend. Companies like financial institutions have money to spend on technology and new software, but individuals are not going out there and buying and the truth will be known when we see the September results come out.

Forbes: That’s covering a lot of waterfront there.

Bill Singer: Can I just ask Hilary one or two quick questions in lieu of making a comment? Hilary, that was spot on. That was wonderful analysis. First of all, let me just tote that I don’t own any of these stocks and I have no intention on buying any of them. I have three companies that a number of companies have run by me and I just wanted to get your thoughts on them to the extent you follow them. One is Chipotle Mexican Grill, which I know has doubled this year. A lot of people wonder if that’s still a good buy or not. The other is a recent listing OpenTable which certain people have discussed as a synthetic ETF almost, which is that you can get exposure to the restaurant industry through a service provider as opposed to restaurants and then in the retail sector
Costco
, just what you think about that. Again, really interesting comments.

Kramer: Thank you. First of all, thank you. I don’t have the numbers in front of me, but I can give you what I’ve noted over the past few months. Costco, as we know, surprisingly same-store sales were down in the last quarter. That was very surprising. The Costco model has been duplicated even at some of the larger supermarkets and they’re struggling, they’re struggling with competition. They’ve done a great job to date but you can’t squeeze anything more out.

On the Chipotle, I’m staying away from the fast food model and Chipotle has you know, look, I won’t short it because I love the Investor’s Business Daily theory, which is never short a high P/E stock. Never short a Green Mountain. Never short a stock that’s on a high speed train. But I think there’s been too much expansion, so I wouldn’t buy but I wouldn’t be shorting it.

And OpenTable, I’m not familiar with enough to make a comment. It’s more Costco that I look at.

Forbes: Ken, any thoughts?

Ken Shubin Stein: I think I’m generally very, very cautious about the amount of disposable income and the amount of discretionary spending that the consumer’s going to do in the next couple of years. And I don’t know whether this will be a strong or a weak recovery, but I do know that for the reasons that were enumerated, including very little access to credit, very challenging job market, for the people who are employed, their salary increases are going to be slow-coming and their health care expenses, even with reform, are likely going to increase significantly per family. Because one of the expenses that in real life hits a family is when a loved one develops significant medical problem as they age or for other reasons. It becomes a family expense. So if someone’s mother or father or brother or sister develops these medical problems, oftentimes that takes money out of the discretionary spending ability of the family. And for all of these reasons, I’d be very concerned about pricing in a significant or fast recovery and things that are luxury or high-priced are very discretionary. And certainly in the travel and leisure and restaurant space, there are plenty of those, some of the ones that Hilary mentioned. So I don’t have any name comments, but I do agree that I would be very cautious on the retail and discretionary spending-type companies.

Forbes: Are these sorts of stocks, retail, travel and restaurants, really bellwethers for an economic turnaround? If they start to pick up, does that mean people honestly feel that the economy has turned around and that it has turned around?

Shubin Stein: I think it depends on what drives it. Sometimes if government policy drives it, it can be fake. You know, in the cash for clunkers program, what we effectively did was we took everybody who was a potential marginal buyer of an auto in the next six to 12 months, and we moved them forward into this period. So we took revenue from future periods and we kind of stole it and dipped it into today’s period. So that’s a direct result of a government policy. So I don’t think that that indicates anything about the strength of the recovery, just we made it worth their while to do so.

Forbes: Here’s hoping the government doesn’t drive us into fast food restaurants. Any other thoughts?

Singer: The other thing is that I’ve kicked around with a bunch of my colleagues and we’ve come up with what we call the “laptop theory” which is that everybody that we know has a laptop that is now three years, four years or five years old. And the theory is that nobody wants to spend the money to get a new one. So we’re convinced that when you start seeing a pick-up in purchasing of laptops, particularly a Dell, that would be an indication that the consumer is beginning to loosen up. Otherwise, Ken’s points are very well-taken, and as I said earlier, I think Hilary is spot on too, so that would be the only comment I have.